Stock Analysis

Associated British Foods (LON:ABF) Might Be Having Difficulty Using Its Capital Effectively

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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Associated British Foods (LON:ABF) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Associated British Foods, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.081 = UK£1.3b ÷ (UK£20b - UK£4.1b) (Based on the trailing twelve months to September 2022).

Thus, Associated British Foods has an ROCE of 8.1%. On its own, that's a low figure but it's around the 9.6% average generated by the Food industry.

See our latest analysis for Associated British Foods

LSE:ABF Return on Capital Employed February 2nd 2023

In the above chart we have measured Associated British Foods' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Associated British Foods Tell Us?

When we looked at the ROCE trend at Associated British Foods, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 8.1% from 13% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Bottom Line On Associated British Foods' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Associated British Foods is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 23% in the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Like most companies, Associated British Foods does come with some risks, and we've found 1 warning sign that you should be aware of.

While Associated British Foods isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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